Research & Development Tax Credit and State and Local Tax Issues September 5, 2018

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1 WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor Research & Development Tax Credit and State and Local Tax Issues September 5, 2018

2 Disclaimers The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, or tax advice or opinion provided by CliftonLarsonAllen LLP to the user. The user also is cautioned that this material may not be applicable to, or suitable for, the user s specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The user should contact his or her CliftonLarsonAllen LLP or other tax professional prior to taking any action based upon this information. CliftonLarsonAllen LLP assumes no obligation to inform the user of any changes in tax laws or other factors that could affect the information contained herein. 2

3 Housekeeping If you are experiencing technical difficulties, please dial: Q&A session will be held at the end of the presentation. Your questions can be submitted via the Questions Function at any time during the presentation. The PowerPoint presentation, as well as the webinar recording, will be sent to you within the next 10 business days. For future webinar invitations, subscribe at CLAconnect.com/subscribe. Our next webinar on 199A and QBI will be held on Thursday, September 20. Please complete our online survey. 3

4 CPE Requirements Answer the polling questions Remain logged in for at least 50 minutes If you are participating in a group, complete the CPE sign-in sheet and return within two business days Contact webmaster@claconnect.com Allow four weeks for receipt of your certificate; it will be sent to you via from support@lcvista.com. * This webinar, once recorded, has not been developed into a self study course. Therefore, watching the recording will not qualify for CPE credit. 4

5 About CliftonLarsonAllen A professional services firm with three distinct business lines Wealth Advisory Outsourcing Audit, Tax, and Consulting More than 5,400 employees Offices coast to coast We serve over 5,000 privately held construction contractors Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC. 5

6 Speaker Introductions Mat Abraham Tax Principal, Tampa, FL Mat is a member of CLA s Federal Tax Strategies (FTS) group, and oversees CLA s East region for FTS. He has 15+ years of public accounting experience, specifically in subject areas that include the Research & Development Tax Credit, Accounting Methods & Inventory, IRC Section 199 (Domestic Production Activities Deduction), and the Tangible Property Regulations. 6

7 Speaker Introductions Daniel Severson Tax Director, Minneapolis, MN Dan joined CLA in 2017 after spending time as a selfemployed sales tax consultant. Prior to starting his own company, Dan spent 10 years as a Sales Tax Auditor with Minnesota Revenue. Dan has audited many of the largest businesses across different industries both in and outside of Minnesota. Dan has audited manufacturers, medical device companies, retailers, auto dealerships and many others. Dan couples this experience with an additional 15 years industry experience from retail and construction to underwriting and finance to provide pertinence and value to CLA clients. 7

8 Learning Objectives At the end of this session, you will be able to: Overview of the Research & Development Tax Credit R&D tax credit s applicability to companies in the Construction Industry Benefits of an R&D study Overview of sales and use tax issues on sales and purchases for contractors Implication of recent United States Supreme Court Decision, Wayfair, for contractors Sales & Use Tax risks and opportunities for contractors 8

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10 R&D Tax Credit Background/History Introduced in the Internal Revenue Code in 1981 A tax incentive provided by the U.S. government to encourage businesses to invest in activities within the U.S. that will provide for product and process improvements and/or the introduction of new products or processes Applicable to C-Corps, S-Corps, LLCs, Partnerships, Sole Proprietorships and Joint Ventures 10

11 R&D Tax Credit Recent Developments Current State of the Credit: Permanent (2015 Path Act) Eligible Small Business can offset Alternative Minimum Tax Average Gross Receipts of $50 million or less Aggregation rules apply Start-up companies, R&D credit can offset employer portion of social security tax Gross Receipts for the year of less than $5 million Absolutely NO Gross Receipts preceding the five year period ending with the year of credit Apply up to $250K of R&D credit against company s payroll tax liability Eligible Industries Building & Construction ( green designs, unique structures), Engineering, Manufacturers, Software Development, Pharmaceuticals, Life Sciences, Medical Research, etc. 11

12 Research & Development Tax Credit Four-Part Test / Qualified Research Activity (QRA) Permitted Purpose Business Component: New or Improved Product, Process, Computer Software, Technique, Formula or Invention Held for sale, lease, license Improve Functionality, Reliability, and/or Quality Technological in Nature Physical Sciences (not social/business science) Eliminate Uncertainty / Section 174 Expenses Buzzwords: Design, Prototype, Test Process of Experimentation Iterative / Trial & Error 12

13 Research & Development Tax Credit Qualified Research Expenses (QRE) - Qualified Wages - Compensation for qualified services - Only includes wages for withholding purposes - Safe-Harbor 80% substantially all rule - Amounts Paid for Supplies - Supplies have to be used or consumed in the qualified research - Contract Research Expenses - 65% of payments paid to third-parties for qualified research - 75% of payments to certain research consortia 13

14 Research & Development Tax Credit Calculation - Qualitative - Computation of Credit: Incremental Credit (Two Methods) - Regular Research Credit ( RRC ) Method - Credit equals 20% of a taxpayer s current-year QREs that exceed a base amount - Compare QREs to Gross Receipts to compute FB% - Existing Company ( info) or Start-Up - Alternative Simplified Credit ( ASC ) Method - Credit equals 14% of the QREs for the taxable year that exceed 50% of the average QREs for the three taxable years preceding the credit determination year - Does not rely on Gross Receipts 14

15 Research & Development Tax Credit Application of Requirements for Qualified Research - Separate Business Components - Substantially All Rule - Shrinking-Back Rule Excluded Activities - Research after commercial production - Adaptation or duplication of an existing business component - Surveys and Studies - Foreign Research - Research in Social sciences - Funded Research 15

16 Research & Development Tax Credit Qualifying Construction Activities - Value Engineering - Design and Build projects - Green building design / LEED certification - Experimenting with new material combinations and evaluation of their performance properties - Designing HVAC systems for airflow and energy efficiency - Plumbing system design for efficient water usage - Lighting system design for energy efficiency 16

17 Research & Development Tax Credit Construction Industry Considerations - Business component for construction & engineering projects? - Design of property - Entire building, building system, or an infrastructure project (e.g., bridge, dam, highway interchange, etc.) - Contract Analysis needs to be performed - Funded Research - Economic Risk & Substantial Rights - Type of Contract (Fixed Price, Cost-Plus, T&M NTE) 17

18 Benefits of an R&D Tax Credit Study: Quantitative & Qualitative support R&D credit is a permanent part of the tax law Congress incentivizes companies to claim the tax benefit Qualitative support essential when presenting results to a taxing authority (e.g., IRS or a state department of revenue) Properly documented R&D study will provide less scrutiny upon tax due diligence in the event of sale of business It should provide confidence to company s auditor regarding benefit for financial statement claimed Establishing a methodology will assist in a refresh R&D study 18

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20 Improvement to Real Property - Materials Contractors are typically associated with contracts to perform improvements to real property Real Property Buildings and structures which are permanent in nature Improvements, in some cases fixtures, which are permanently attached to buildings or the land itself Cannot be removed without substantial damage to the building or structure 20

21 Purchases by Contractors When performing improvements to real property, a contractor is considered to be the end user of all materials purchased to fulfill contract Sales tax paid on cost of materials Must pay state and local sales/use tax First Use most likely where first delivered to Incremental local tax where used, if higher Sales tax amount should be built into the bid Contractor must pay sales tax on cost of all equipment owned or leased Sourcing Interstate movement of equipment Accrue and remit use tax if sales tax not charged by vendor 21

22 Improvement to Real Property - Labor Generally labor to perform improvements to real property is not subject to sales tax No sales tax would be charged by the contractor to the end customers However certain states do tax construction labor (not all inclusive) Iowa Exempt if new construction, or remodeling. Materials also taxable. Texas Exempt if new construction Washington Exempt if initial construction by developer for sale 22

23 Installation of Tangible Personal Property Not considered permanently attached to building Can be removed without causing substantial damage Example, light fixtures, though this varies by state In MN and many other states installation of tpp is treated as the retail sale of tangible personal property Labor and materials subject to sales tax on retail selling price If not appropriately collected on sale, contractor may be forced to eat the tax if audited 23

24 What is Wayfair? South Dakota v. Wayfair, et. al. is a 5-4 U.S. Supreme Court decision issued on June 21, The Court overturned the physical presence requirement for sales and use tax collection obligation from Quill Corp. v. North Dakota (1992). States now have the possibility of enforcing a sales tax collection requirement (nexus) over remote sellers. The Court did not rule on the constitutionality of any particular economic nexus law, but sent the case back to SD to address this The House Judiciary Committee met recently about Wayfair 24

25 Wayfair The Court Decision The Court overturned Quill It acknowledged that Congress could take action which has started The Court did not decide whether SD s law was constitutional It sent the case back (remanded it) to the SD court system to decide whether SD s law places an undue burden on interstate commerce The undue burden test is unknown, though the Court suggested the balancing test of Pike v. Bruce Church, Inc. (1970) However, the Court suggested that SD s law would be upheld because of three specific aspects of that law (the blueprint ) 25

26 Who is a Remote Seller? The term remote seller is often thought of as a company who sells goods/services over the Internet. However, it can apply to any company who makes sales into a state where it does not maintain a physical presence: Online sales Purchase orders Telephone orders Automatic replenishment order systems supply chain management Wayfair does not only apply to Internet sellers! 26

27 Wayfair Impact to Contractors and Real Estate Industry Most contractors and real estate property managers already have physical presence in a state, thus minimal impact Property Employees Impacts sales tax on sales if contractor self-fabricates items such as fixtures and sells interstate without installation More vendors will be charging sales tax If in a state, where contractor can claim temporary storage on construction materials, will need to provide exemption certificate to more vendors Drop Shipments, more vendors will have nexus Biggest impact is on retail sales 27

28 Contractor - Retailer Contractors may sell construction related materials at retail Options to avoid double taxation Purchase all materials exempt for resale (Risk) Collect sales tax on sale Remit use tax for taxable use Pay sales tax on all purchase of materials (Refund Opportunity) No use tax due when pulling from inventory for own use Collect sales tax on retail sale to customers File refund to claim sales tax paid on cost of materials 28

29 Self Manufactured Construction Materials Examples: Cabinet Makers/Store Fixtures Manufactured and installed by contractor Purchase materials exempt for resale Use tax due on materials used to self manufacture Cost Cost plus a markup Fair market value of retail price Some states state that the labor is also subject to tax in order to make it equivalent to purchasing from a third party 29

30 Sales/Use Tax Audit Risks Contracts with Exempt Organizations All risk is on the Contractor All required protocols must be followed in order for the contractor to purchase materials exempt, using customer s exemption Minnesota Separate contracts for materials and labor Contractor must be authorized as a purchasing agent Owner, and not contractor bears risk of loss for materials Materials are owned by exempt organization Contractor only an intermediary, does not provide warranty for defects In place and effective prior to first invoice for materials for project Contractor provides owners exemption certificate with Purchasing Agent authorization Common sense not applied, all documentation must be signed and dated prior to project start Other states require a project exemption certificate with a specific project number Competitive disadvantage if other contractors are willing to bear the risk 30

31 Sales/Use Tax Audit Risks Moving equipment and materials between states Sales tax due where materials are first delivered Incremental state and local use tax potentially due based on project location if sales tax rate is higher than sales tax rate already paid based on delivery Multiple entities Moving equipment between entities could create a taxable transaction Intercompany leases are taxable Pulling self-manufactured materials for installation in real property, i.e. asphalt or concrete is a taxable event Contractor/Retailer purchased items exempt but didn t accrue use tax when used for own purpose or collect sales tax when sold to customer 31

32 Sales/Use Tax Refund Opportunities Contractor/Retailer Tax is double paid Paid tax upfront for a taxed inventory and then accrued use tax when pulled from inventory or collected tax on sale to customer Refund due for sales/use tax paid on the cost Self-Fabricated Materials and Fixtures Equipment used to manufacture the materials can qualify for the manufacturing exemption if materials are predominantly sold at retail Sold at retail can mean a related entity Set up a manufacturing entity if don t meet the predominantly used threshold Exemption would also cover utilities, items used and consumed in production, R&D, Testing and Quality Control 32

33 Sales/Use Tax Refund Opportunities Fuel used for off-road use and auxiliary motors such as Power Take off Units, i.e. a cherry picker Exemption may apply to fuel tax or sales tax and in some states both could qualify for exemption Must pay the tax upfront and then claim the refund Concrete Mixers on trucks (specifically listed in MN) Trucks used in recycling (Iowa) 33

34 Sales/Use Tax Refund Opportunities Mining/Excavating Qualifies for manufacturing exemption in most states Manufacturing process may begin when extracted from the ground or immediately after extraction Drilling equipment may qualify Crushing equipment and conveyors would qualify Utilities and gas used to run the equipment would qualify 34

35 Sales/Use Tax Refund Opportunities Recycling Can qualify for manufacturing if creating new product Start of process varies by state between where the waste product to be recycled is picked up to when it first enters the manufacturing process Specific exemptions for waste recycling facilities Milling machine used to tear up roads can qualify as a stand alone recycling facility in MN 35

36 Sales/Use Tax Refund Opportunities Large Property Managers Sales tax is complicated when covering multiple states Sales/use tax decisions made at local level May be over accruing use tax to avoid audit risk Certain types of software purchases may qualify for exemption Cloud based or electronically delivered software Software Maintenance 36

37 Questions? 37

38 Questions? Mathew Abraham, Principal, Federal Tax Strategies CLAconnect.com Dan Severson, Tax Director Ben Theuninck, Principal To receive future webinar invitations, subscribe at CLAconnect.com/subscribe. linkedin.com/company/ cliftonlarsonallen facebook.com/ cliftonlarsonallen twitter.com/ CLAconnect youtube.com/ CliftonLarsonAllen

39 Please join us for the rest of our CPE webinar series on Tax Reform: 199A and Qualified Business Income Thursday, September 20 at 11 am cst Entity Choice S Corp vs. C Corp Tuesday, October 30 at 11 am cst For further details, please visit our event page at: For the latest news and updates on tax reform, please visit: 39